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Hercules Offshore, Inc. (NASDAQ:HERO)

Capital One Southcoast 8th Annual December Energy Conference

December 12, 2013 12:40 PM ET

Executives

Craig Muirhead, Vice President and Treasurer

Son Vann - Vice President, Investor Relations and Planning

Analysts

Pierre Conner - Capital One Southcoast, Inc.

Pierre Conner - Capital One Southcoast, Inc.

Well, thank you very much. We will continue on with the next presentation, Hercules Offshore. Hercules operates a large fleet of jackups in the Gulf of Mexico and is one of the largest liftboat operators in the world. Recently they streamlined their operations with divestiture of some of the barge rigs and their Gulf of Mexico liftboat fleet.

I am fortunate to have Son Vann, Vice President, Investor Relations and Planning, and Craig Muirhead, Vice President and Treasurer. We'll do about 20 minutes in here and then I think there will be breakout session. So, do you want to start us off? Very good, thank you. You got your monitor, forward backward, wherever and I will do that just to help you stay on time.

Son Vann

Great. Well, thanks, Pierre, and thanks everybody for joining us at the Hercules presentation. So as with everyone else please be mindful of our forward-looking statements disclosure.

Hercules Offshore is a leader in shallow water service provider to the E&P industry worldwide. We have 40 jackup rigs, which is the third largest fleet in the world. We have 24 liftboats, 21 in West Africa, 3 in the Middle East, and that's the largest fleet of liftboats outside of the Gulf of Mexico. If you look at the map, we have operations or have had operations in all of the major shallow-water regions in the world. We have a highly experienced management team with experience effectively managing through the cycles.

We have been busy in 2013, executing on a number of our strategic objectives. One is we’ve high graded our asset base by the acquisition of the two ultrahigh-spec jackups from Discovery Offshore. Those are new build Super A class rigs, high-temperature high-pressure, capable of working anywhere in the world outside of Norway. We are very excited to have those rigs as part of our fleet. Those are new assets for us that we’ll be able to work through the cycles for the next 30 years and we have also acquired our highest spec liftboat and the Bull Ray, which is currently working in West Africa, paid $42 million for that liftboat. It's our highest spec liftboat in the fleet, also a very good way to start high grading and renewing our fleet on the liftboat side.

Along with that, we sold our domestic liftboat business and our inland barge business earlier this year. Both of those businesses were about cash breakeven and we tried various things over the last couple of years to improve those businesses. We tried to consolidate the domestic liftboat business back in 2011 and we were unsuccessful in that effort. We could not see a clear path forward for growth in those businesses and so felt it was the best course to exit those businesses. The timing was convenient in that we were able to use the 110 million or so of proceeds from the sale of those businesses to complete the acquisition of Discovery without issuing any additional equity.

We have increased our earnings visibility through this year with the continued improvement in the Gulf of Mexico, increasing backlog as well as long-term five-year extensions on two of our rigs in Saudi Arabia working for Aramco. That has moved our revenue backlog to the highest level that we have recorded as a company at the end of the third quarter. And we continue to chip away at our balance sheet. We refinanced some higher coupon debt earlier this year extending the maturity and lowering our borrowing costs.

I mentioned the acquisition of the Discovery rigs earlier this year. These are now fully under the Hercules umbrella. Our first of those rigs went to work for Cairn in India, in November, and that is working at $215,000 a day, which is a very good rate comparable to the new fixtures for rigs of this class in the North Sea.

When you factor in the $13 million mobilization, and mobilization cost from Singapore to India is much less than mobilization cost from Singapore to the North Sea. Anyway, factoring in the $13 million mob fee over a four-month contract, given effective dayrate of $330,000 a day, which is an extremely attractive rate for a rig of this class.

A lot of people think that [North Sea] [ph] is the only place where you can get premium dayrate for rigs of this class. We've shown with this contract that there's opportunities in other areas, so this is a very good rate. We think there could be additional work behind this job with Cairn, but there's also opportunities in West Africa, in the Middle East, and in other regions.

We are targeting long-term work for both our Triumph and the Resilience, our other Discovery rig, but in the interim we will work on some short-term jobs like this. The Cairn job, obviously is at very attractive rate. Our Resilience, when it comes out of the yard may work in the Southeast Asia spot market just to pick some short-term gap filler work in advance of a longer-term contract. If it ends up in that market, the Resilience rate could be somewhere between 170 and maybe 200, depending on the type of work that's available at the time.

As I mentioned a little bit earlier, we signed two contract extensions with Aramco for five years each. These are at 50% higher dayrate than where these rigs are currently working at today and it extends the backlog out through the end of 2019, so we are very excited about these contract extensions. It's a great contract for the company, both of these are good and it demonstrates our good relationship we have with Aramco. But we think it also is a very good sign of Aramco's view of the supply and demand balance in the jackup market over the next several years that the largest oil company in the world and largest jackup consumer in the world would extend two 30-year old assets out on long-term extensions in the face of 134 new builds coming into the market, right about the time that these extensions would start. If they thought that the jackup market was going to have a glut of supply, they would probably not sign these long-term extensions at such an increase in dayrate so far in advance of the contract start.

Turning to Domestic Offshore, this has been our largest segment. And those of you that follow us know that the last few years have been quite a ride for us domestically. 2009, 2010 were very challenging, but it affords us the opportunity to purchase our largest competitor at the beginning of 2011 at a very good price just as the market was beginning to take off again. Since that time, domestic utilization has averaged 90% or better, backlog per rig has extended quite significantly and dayrates have tripled.

If you were to look at the supply and demand balance in the Gulf of Mexico, there is 58 jackups currently located on the U.S. side of the Gulf of Mexico, 20 of those are cold stacked, leaving about 38 rigs in the marketed supply. Of those that are a handful that are workover-only, they don't have the equipment to effectively drill new holes, so all of the drilling jackups are effectively fully utilized with 35 rigs under contract today.

Of the 20 cold stacked rigs, Hercules owns eight of those rigs. The remaining cold stacked rigs are owned by ENSCO, Rowan and Diamond. We don't see those guys' business models leading them towards reactivation of cold stacked rigs, so effectively Hercules owns all of the reactivation potential in the Gulf of Mexico, and I will go into that in a little bit more in a couple of slides here.

Our average backlog per rig peaked at the end of last year. We signed three long-term deals with one of our good customers in the Gulf of Mexico. We have worked off those contracts throughout this year and we expect to renew those contracts in the next several weeks on those three rigs, and so you will see an improvement in our backlog once those contracts are in place.

This slide shows our dayrates over the last several years, and they are moving in exactly the right direction you would like to see on a revenue slide, so we have been happy with that day rate movement. We are not quite to the previous peaks that we saw in 2007, but we are moving in that direction and each new contract we sign is at higher rates than the last contract, so we are still continuing to see improved dayrates.

Our customer base in the Gulf of Mexico is large and is diverse. The top-three operators take up about 30% of the rig demand and then the remainder of the rig demand is taken by a number of different competitors. There were 23 total operators in 2009 in the Gulf of Mexico Shelf. There's 35 operators today. That increase is largely due to some new private equity backed new entrants and those guys that have purchased properties from some of the existing operators, so for example you look at Riverstone purchased the Apache shelf properties that new company is called Fieldwood. We view this as a very positive development for the Gulf of Mexico market on drilling activity.

Apache looked at their shelf properties essentially as a cash cow and they focused their real growth efforts in their other areas, but for Fieldwood, all they have got is the Gulf of Mexico shelf, and so they will focus their growth efforts on the shelf and we see this as an increase in demand for drilling activity in the Gulf of Mexico. The other operators or these other acquisitions as well, people don't buy properties to sit on them. They buy properties to work them, and most of that work requires a drilling rig, so we see these property acquisitions as a driver of demand growth in the Gulf of Mexico.

And I mentioned a little bit earlier, we view ourselves as the only likely candidate for reactivations in the Gulf of Mexico. We have done one reactivation. We completed our Hercules 209 earlier this year. That rig is currently working at $110,000 hundred a day, which gives you about a seven-month payback on the $14 million reactivation cost of that rig.

We are currently in process of reactivating our Hercules 203. We anticipate reactivation cost to be somewhere in the $20 million ballpark to get that back into shape that the rig was in before. It was cold stacked. And at today's rate of $110,000 still gives you less than a year payback. That rig, we expect to be ready sometime next fall.

We will look at additional reactivations, but we will be deliberate in those reactivations in that we don't want to add supply too much or too quickly to the market and upset the current balance that we have between supply and demand. Although we do see our operators looking to add rigs to the fleet, in the future so we will continue to add supply so long as we see that demand increasing enough to take it without impacting the rest of the fleet dayrates.

With a large operation in the Gulf of Mexico, we have a lot of operating leverage, and with improving dayrates, those flow through to earnings in a meaningful way. With our 18 rigs, $15,000 increase in dayrates equates to about $90 million in annual EBITDA. We recorded our average revenue per day in the third quarter of about $85,000 per rig. Today, we are working at about $100,000 a day and we are signing contracts in $110,000 range, so a material increase in our earnings as we are signing new contracts and as we work off some of that backlog at higher rates.

One of the questions we get from investors is the Gulf of Mexico market seems really good. At what point do rigs from other regions start coming back to the Gulf of Mexico?

Well, we don't see that happening. Obviously, I think the Diamond rig came back a little bit recently, but we see that as an unusual occurrence. We don't see other operators bringing rigs back And that’s because the international markets are so good, all of the other major regions for jackup rigs are working full out, so those rigs can get work where they are, so the opportunity cost to leave their current job, to purchase a heavy lift that you are not going to be reimbursed for from the Gulf of Mexico operator is too high to make sense for people to come back in the Gulf of Mexico. So we don't see that as the source of rigs into the Gulf of Mexico for the next several years.

As I just mentioned, the international markets all are very strong. In the top major market, the rig count today is higher than what it was in the last peak in 2008. The Middle East, Mexico, West Africa, all of those regions are running full-out. They are looking for additional rigs. In fact the top customers in the world Aramco and PEMEX doubled their rig counts since 2011 and they have indicated they are looking to significantly increase their jackup counts as well. In fact, we have heard numbers from PEMEX looking to go from 44 rigs that they are running today up to 90 rigs.

PEMEX doesn’t always do everything that is indicated that they intend to do, but at least it shows their bias towards significantly increasing their rig count. From where we are today, and the jackup demand that we see for major customers like Aramco and PEMEX and others, we see the demand for jackups increasing to absorb all of the new supply coming online in '14 and '15.

When we started the Discovery project, we were looking at what types of rigs to build that would be the best investment for new rig into our fleet, so we historical dayrates for different classes of rigs, and you look at the incremental cost of building an ultrahigh-spec rig like our Discovery rigs 2 million pound truckload, harsh environment, high-spec rigs, versus the dayrate that you can get on those rates compared to standard spec new build rigs. The dayrates that you got on ultrahigh-spec rigs much higher far justify the incremental capital that it cost to build those ultrahigh-spec rigs and so that's the reason we chose the ultrahigh-spec market. In addition, all of the ultrahigh-spec rigs over the past several years worked continuously through the cycle. There was no down cycle for the ultrahigh-spec rigs, so we are excited about the prospects for our Discovery rigs and we are targeting long-term contracts on those and hopefully we will have to discuss with you here very shortly.

So, look at our international fleet status, as I mentioned a little bit before, our Triumph is currently working for Cairn in India at $215,000 a day. We think there is the possibility for additional work with Cairn after this current contract, but we are long-term work with that rig outside of India. We are also targeting long-term work for the resilience, but may potentially work it in the spot market as a gap-filler between delivery and the start of the long-term jobs.

Most of our other rigs are working throughout 2014. Our 267 as we have got in Angola, our three rigs in Saudi Arabia are well contracted. Our Hercules 208 is going to start work with Cairn in India in the first quarter and will likely work the Resilience. We think there is good opportunity to extend that we Cairn past the initial contract. Our Hercules 260 is working for Perenco in West Africa. We think there is opportunity to extend with that customer, but if not there is ample opportunities with other customers in that region for this rig.

Turning quickly to the domestic liftboats, we are the largest liftboat provider outside of the Gulf of Mexico. We have got 21 liftboats in West Africa, including our new acquisition of the Bullray, as I mentioned, but we bought that rig $42 million. It's currently working at $65,000 a day and has been since we purchased it. OpEx on that liftboat is about $15,000 a day, so very profitable asset for us and we will continue to look for growth opportunities in the liftboat business such as the Bullray. I think that's a good target for where we are looking to grow our business.

The work in West Africa is about well works, the well intervention wireline, coiled tubing and things like that and about 50% construction and maintenance. In the Middle East, our three liftboats were almost exclusively on construction, repair and maintenance. In fact, a lot of the work is accommodations, so we will pull up next to a platform where they are doing construction and maintenance work and function effectively as a mobile hotel for that type of work. We expect our Middle East business, we signed some long-term contracts in the Middle East, so we should see an improvement in that business from utilization standpoint in 2014.

So, we will circle back around to few of the things we have spoken about. We have very active year in 2013, adding new assets to our fleet, divesting some of our lesser performing assets and this really serves to balance our revenue on a geographic basis as well as high-grade our fleet towards newer assets, and we recorded the highest revenue backlog as a company in the third quarter and we have opportunity to improve that as we sign long-term contracts on Discovery rigs and these three contract intervals on our domestic rigs with our large customer.

So, wrapping it up quickly, we are excited about our Discovery acquisition. This high grades our fleet, first step in fleet renewal as 30-year assets that will work through the cycles to our fleet. We are also excited about Bullray, liftboat acquisitions for the same reasons. There is positive industry trends in the Gulf of Mexico. Our customers are looking to increase their rig counts. Fieldwood, just thinking of the Apache properties, looking to work those properties if you are going to EPL or [21]'s presentations there's a lot of new seismic activity that could lead to additional opportunities for customers on the shelf, so we think that's a good driver of demand in the Gulf of Mexico.

The international markets are very strong as demonstrated by our two five-year extensions with Aramco. We have got good backlog, continue to [sit] with our balance sheet and we feel like we have good management team with experience effectively managing through the cycles.

With that, I will wrap it up and hope to see some of you guys in the breakout session, so than you very much.

Question-and-Answer Session

[No Q&A session for this event]

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Source: Hercules Offshore's Management Presents at Capital One Southcoast December Energy Conference (Transcript)

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